Employee share ownership plans can be risky. What there is to know

Operation of employee share ownership plans

Typically available to all employees, ESPPs can let you buy company stock at a discount of up to 15%, capped at $25,000 per year for tax-eligible plans.

The plan collects after-tax contributions from each paycheck during an “offer period” and uses the funds to purchase shares of the company on a specific date.

“The gold standard for a plan is going to be a 15% discount with a lookback feature,” said Bruce Brumberg, editor and co-founder of myStockOptions.com.

A “lookback” provision bases the purchase price of the shares on the value at the beginning or end of the offer period, whichever is lower. For example, suppose your ESPP offers a 15% discount and rollback. With a starting price of $20 and an ending price of $22, you’ll get a 15% discount on $20, for a total saving of 22.7% per share.

Nearly 4 in 10 public companies offer discounts and rollbacks for ESPPs, according to a 2022 report from Morgan Stanley at Work.

What you need to know before selling your shares

While it may be tempting to cash in your shares at a discount, there are complex tax rules to consider, including rebate levies. The distribution of regular income and more favorable long-term capital gains depends on when you sell.

Your employer may also ask you to keep the shares for a specified period. “Some companies have an additional holding period requirement,” Brumberg said. “They don’t want you flipping the shares.”

The gold standard for a plan will be a 15% discount with a look back feature.

Bruce Brumberg

Editor-in-chief and co-founder of myStockOptions.com

Of course, there are other key details to be confirmed in the plan document.

You’ll want to know if the ESPP is tax-eligible, what may offer savings, as well as how to enroll, length of the offer period, purchase dates, how to make changes, and what happens next. happens if you opt out of the plan. , he said.

Check ‘all other boxes’ before an ESPP

While a bear market may offer an even deeper discount, allowing you to buy more shares, there are other trade-offs to consider before jumping in.

There’s no guarantee you’ll make a profit because “stocks don’t always go up,” McKenna said.

Indeed, most individual stocks are not outperforming the market, according to analysis by JP Morgan. From 1980 to 2020, nearly 45% of companies in the Russell 3000 index suffered a 70% price decline from the peak and never recovered, according to the report.

Given these risks, experts may suggest an ESPP to supplement your 401(k), rather than as your primary way to save and invest. And you’ll always want to weigh your risk tolerance and goals before signing up.

An ESPP may be worth considering if you’re already meeting your other financial goals, such as maximizing your 401(k), investing in a brokerage account, paying off debt or other savings goals, McKenna said. .

It may work once you’ve “checked all the other boxes,” she said, but it may be best to focus on other planning opportunities first.

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